Corporate Governance Guidance and Principles for Unlisted Companies in the BalticsAn initiative of the Baltic Institute of Corporate Governance and ecoDa

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!is document is a practical tool for the share-holders, directors and stakeholders of unlisted companies.

The original pan-European edition of the guidance - Corporate Governance Guid-ance and Principles for Unlisted Compa-nies in Europe - was published by the Euro-pean Confederation of Directors’ Associa-tions (ecoDa) in March 2010. It was devel-oped by an ecoDa working group chaired by Prof. Dr. Lutgart Van den Berghe, Chair-woman of ecoDa’s Policy Committee and Executive Director of GUBERNA (Belgium).

!e working group also included:

Juan Álvarez-Vijande, Chairman of ecoDa and Executive Director of IC-A (Spain);

Dr. Roger Barker, Head of Corporate Governance at the IoD (UK);

Philippe Decleire, Chairman of ecoDa’s membership committee and Treasurer;

Jean-Philippe Drescher, Chairman of ILA’s Financial Companies’ Committee (Luxembourg);

-rector of Governance programs at HEC Executive Education, Senior Partner of ”Associés en Gouvernance” consulting

-panies’ commission (France);

Irena Prijovic, ecoDa board member and Secretary General of ZNS (Slovenia);

Béatrice Richez-Baum, Secretary Gen-eral of ecoDa;

Olli V. Virtanen, ecoDa Board Member, Chairman of ecoDa’s Sponsorship and External Communication Committee and Secretary General of Hallitusammatti-laiset ry (Finland);

Axelle Wibault, Junior Coordinator and Researcher, GUBERNA (Belgium).

ecoDa is particularly grateful to Prof. Dr. Lut-gart Van den Berghe and Dr. Roger Barker, both of whom made significant contributions to the drafting of the pan-European version of the document.

A UK edition has been adapted for the UK business environment by Dr. Roger Barker, Head of Corporate Governance at the IoD & published in November 2010.

This Baltic edition has been adapted by the Baltic Institute of Corporate Governance (BICG).

First edition: July 2011Baltic Institute of Corporate Governance. All rights reserved.

Published by:Baltic Institute of Corporate Governance Jogailos 4VilniusLithuania

www.corporategovernance.eewww.corporategovernance.lvwww.corporategovernance.lt

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About the Baltic Institute of Corporate Governance

The Baltic Institute of Corporate Govern--

mental association with strong involvement from Baltic business and political leaders.

The BICG is leading the way in Baltic cor-porate governance by helping to create better governed public and private com-panies.

The BICG as an association is governed by its members. The relationship between the Association’s members, the Board, the Council, management and other stakehold-ers is regulated in the bylaws of the Asso-ciation.

of the Global Corporate Governance Forum www.gcgf.org as well as a member of eco-Da, the European Confederation of Direc-tors’ Associations www.ecoda.org

About ecoDa

ecoDa, the European Confederation of Di--

sociation acting as the European voice of board directors, active since March 2005 and based in Brussels. On behalf of its 11 national institutes of directors, ecoDa en-sures that their views on corporate govern-ance are clearly communicated to policy-makers in the EU institutions. ecoDa acts as a high-level forum for debate and for the exchange of experiences to promote high standards for directors in Europe. It acts as a standing body where national experi-ences are shared and discussed in detail. www.ecoda.org

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Quotes about the Baltic, UK and European editions

”Unlisted companies make a major con-tribution to economic growth and employ-ment in all European countries. However, the corporate governance needs of such companies have until recently been rela-tively neglected by governance experts and policy-makers. This publication will assist unlisted Baltic companies in the de-sign and implementation of an appropriate corporate governance framework. Baltic

-tive context of the Baltic business environ-ment.”

Dr. Roger Barker, Head of Corporate Govern-ance, Institute of Directors, London

As investors, we see good corporate gov-ernance as well as environmentally and socially responsible behavior as essential in managing any company with the aim of maximizing long-term shareholder value. In our investment region, improving corporate governance is an important and obvious

-tract investors. Companies which are man-aged along clear and credible principles that align shareholder interests; with an in-

reporting are clearly better positioned to

increase investor interest. This publication is an excellent guide to unlisted companies in the Baltics wanting to implement a gov-ernance framework based on international best practice.

Louise Hedberg, Head of Corporate Govern-ance, East Capital AB

For decades capital market experts have beavered to develop governance advice meant to produce healthy listed companies that last, create jobs and contribute to pros-perity. However, much of the wealth gener-ated in economies comes not from com-panies on stock markets, but from unlisted enterprises. We want those too to be strong and sustainable. Now comes this timely set of principles, which offers important, practi-cal and useable guidance to corporations, managers and investors. It also gives other

and civil society organizations—a tool to test whether unlisted companies are best

Stephen Davis, Ph.D., Executive DirectorMillstein Center for Corporate Governance & Performance, Yale School of Management

bullet” in the form of laws and regulations to improve board performance. That leaves the private sector with a major responsibil-ity to improve board practices through, in-ter alia, implementing voluntary standards. This is particularly the case in unlisted com-panies, where the long-term success of the company, including its strategy depends on an effective board.”

Fianna Jesover, Senior Policy Manager, Corpo-rate A"airs Division, OECD, Paris

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Foreword by the President

Of the registered companies in the Baltics, the overwhelming majority are SMEs or start-up companies that remain under the ownership and control of the founder or founding family/group.

Such unlisted enterprises are the backbone of the Baltic economies. They account for upwards of 70% of the GDP and employ-ment. Furthermore, they are a key source of dynamism and entrepreneurial spirit. Their potential contribution to any economic growth should not be underestimated.

-minder of the need for a robust governance framework in the global banking sector. However, good governance is not only rel-

-ed companies. The BICG is convinced that appropriate corporate governance prac-tices can contribute to the success of Baltic companies of all types and sizes, including those that are unlisted or privately held.

In this document, fourteen principles of good governance for unlisted companies are presented on the basis of a dynamic phased approach. This takes into account the size, complexity and level of maturity of individual enterprises. Unlisted companies – such as founder and family-owned busi-nesses – can utilise this stepwise frame-work to ensure their long-term sustainability, to bring external parties to their boards, to attract funds, and to solve issues between shareholders and other stakeholders.

Although only applicable on a voluntary ba-sis, the Principles and Guidance included

in this document provide practical advice for unlisted Baltic companies that wish to establish an effective and value-adding governance framework at each stage of their development process.

This initiative has been made possible thanks to strong support from the individual and corporate members of the BICG, es-pecially DnB Nord Bank and the Board and Council members of the BICG as well as the pioneering work of ecoDa, which devel-oped the original European text from which this Baltic edition has been adapted.

Finally a big thank you to Dr. Roger Barker ! the Chair-

man of BICG and Robertas Degesys from Baltic Legal Solutions for their contributions to this Baltic edition.

Kristian Kaas Mortensen

President Baltic Institute of Corporate Governance

Corporate Governance Guidance and Principles for Unlisted Companies in the BalticsAn initiative of the Baltic Institute of Corporate Governance and ecoDa

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Executive summary

This BICG and ecoDa initiative offers a corporate governance agenda for un-listed companies in the Baltics.

Unlisted companies make a major con-tribution to Baltic economic growth and employment. However, the corporate governance needs of unlisted compa-nies have, to date, been relatively ne-glected by governance experts as well as by policy-makers. In particular, the Es-tonian, Latvian and Lithuanian Corporate Governance Codes are primarily aimed at listed rather than unlisted enterprises.

Many unlisted enterprises are owned and controlled by single individuals or fami-lies. Good corporate governance in this context is not primarily concerned with the relationship between boards and ex-ternal shareholders (as in listed compa-nies) nor with a focus on compliance with formal rules and regulations. Rather, it is about establishing a framework of com-pany processes and attitudes that add value to the business, help build its repu-tation and ensure its long-term continuity and success.

Good corporate governance is particu-larly important to the shareholders of unlisted companies. In most cases, such shareholders have limited ability to sell their ownership stakes, and are there-fore committed to staying with the com-pany for the medium to long term. This increases their dependence on good governance.

Good governance can also play a crucial role in gaining the respect of key exter-nal stakeholders. In an environment of mounting societal scrutiny towards the business world, even unlisted companies

will have to take account of their corpo-rate responsibilities towards their stake-

from a gradually increasing transparency and accountability.

An effective governance framework de-

distribution of power amongst sharehold-ers, the board, management and other stakeholders. Especially in smaller com-panies, it is important to recognise that the company is not an extension of the personal property of the owner.

-listed companies on the issues involved in designing an appropriate corporate governance framework. It also presents a set of governance principles that can be followed or not. This remains a voluntary decision of each unlisted company.

Fourteen principles of good governance are presented on the basis of a dynamic phased approach, which takes into ac-count the degree of openness, size, complexity and level of maturity of indi-vidual enterprises. A dynamic approach towards governance is essential, since governance frameworks must evolve

A key step in the development of unlisted company governance is the decision to invite external directors onto the board. Its effect on boardroom behaviour and culture should not be underestimated.

The principles provide a governance roadmap for family owners or founder-entrepreneurs as they plan the develop-ment of their companies over the corpo-rate life cycle. These principles may be relevant for subsidiary companies and joint ventures as well.

Phase 1 principles: Corporate governance principles applicable to all unlisted companies

Principle 1: Shareholders should estab-lish an appropriate constitutional and governance framework for the company.

Principle 2: Every company should strive to establish an effective board, which is collectively responsible for the long-term success of the company, including the

-ever, an interim step on the road to an ef-fective (and independent) board may be the creation of an advisory board.

Principle 3: The size and composition

complexity of the company’s activities.

Principle 4: The board should meet suf-

and be supplied in a timely manner with appropriate information.

Principle 5: Levels of remuneration

motivate executives and non-executives of the quality required to run the company successfully.

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Principle 6: The board is responsible for risk oversight and should maintain a sound system of internal control to safe-guard shareholders’ investment and the company’s assets.

Principle 7: There should be a dialogue between the board and the shareholders based on the mutual understanding of objectives. The board as a whole has re-sponsibility for ensuring that a satisfactory dialogue with shareholders takes place. The board should not forget that all share-holders have to be treated equally.

Principle 8: All directors should receive induction on joining the board and should regularly update and refresh their skills and knowledge.

Principle 9: Family-controlled compa-nies should establish family governance mechanisms that promote coordination and mutual understanding amongst fam-ily members, as well as organise the rela-tionship between family governance and corporate governance.

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Phase 2 principles: Corporate governance principles applicable to large and/or more complex unlisted companies

Principle 10: There should be a clear division of responsibilities at the head of the company between the running of the board and the running of the company’s business. No one individual should have unfettered powers of decision.

Principle 11: All boards should contain -

tencies and experiences. No single per-son (or small group of individuals) should dominate the board’s decision-making.

Principle 12: The board should establish appropriate board committees in order to allow a more effective discharge of its du-ties.

Principle 13: The board should undertake a periodic appraisal of its own perfor-mance and that of each individual director.

Principle 14: The board should present a balanced and understandable as-sessment of the company’s position and prospects for external stakeholders, and establish a suitable programme of stake-holder engagement.

Corporate Governance Guidance and Principles for Unlisted Companies in the Baltics

This publication is the Baltic edition of pan-European guidance developed by the European Confederation of Directors’ Associations (ecoDa). It has been adapt-ed to the Baltic business context by the Baltic Institute of Corporate Governance (BICG).

The following pages provide guidance and a set of voluntary “best practice” principles for Baltic companies, drawing on both the content of existing national and international corporate governance codes and the experience of good gov-ernance in individual unlisted enterprises.

The guidance is contained in Part I of

the rationale for the publication of a set of corporate governance guidance and principles for unlisted companies. Sec-tions 3 and 4 provide a glossary of the rel-evant governance actors and concepts that should be incorporated into a viable corporate governance framework. Sec-tion 5 considers some of the challenges involved in the implementation of good corporate governance.

The statement of the 14 corporate gov-ernance principles for unlisted compa-nies is undertaken in Part II. Those read-ers that are already well versed in corpo-rate governance concepts may wish to turn directly to Part II, in order to focus on the measures that can be directly applied at the level of each company.

Part I – Guidance on corporate governance for unlisted companies

!e OECD defines corporate governance as follows:

“Corporate governance involves a set of relationships between a company’s man-agement, its board, its shareholders and other stakeholders. Corporate govern-ance also provides the structure through which the objectives of the company are set, and the means of attaining those ob-jectives and monitoring performance are determined. Good corporate governance should provide proper incentives for the board and management to pursue objec-tives that are in the interests of the com-pany and its shareholders and should fa-cilitate effective monitoring”1.

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1) Why focus on unlisted companies?

The purpose of corporate governance is to facilitate effective and prudent manage-ment that can deliver the long-term suc-cess of the company.

The focus of the following corporate govern-ance guidance and principles is on unlisted companies, i.e. limited companies that are not listed or quoted on public equity mar-kets2. The scope of unlisted companies is very wide and encompasses start-ups, sin-gle owner-manager companies, family busi-nesses, private equity-owned companies, joint ventures, and subsidiary companies.

Unlisted companies are of particular im-portance in countries with less developed capital markets such as the Baltic States, where the vast majority of companies are not listed on a stock exchange or regulat-ed market. In the Baltics most small and medium-sized enterprises are not publicly listed on regulated equity markets. Further-more, there exist many notable large cor-porations that have chosen – for a variety of reasons – to forgo a public listing.

According to the OECD, improved corpo-rate governance amongst unlisted compa-

productivity growth and job creation3. However, despite their large numbers and economic importance, the governance of unlisted companies is an often neglected area of corporate governance studies and recommendations.

1 OECD Principles of Corporate Governance, 2nd Edi-tion, 2004, page 11.

2 The key difference between unlisted and listed companies is that unlisted companies are not issuing shares to the public. Consequently, their shares are not traded on public equity markets. They may also impose restrictions on the transferability of their shares.

3 Vermeulen (2006), page 93.

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In recent years, many countries have adopted corporate governance codes4. In the Baltics, national corporate governance codes for listed companies are published by the operators of the regulated markets in Estonia, Latvia and Lithuania5. Since 2007 all Baltic listed companies annually report on their adherence with these corporate governance codes on a “comply or ex-plain” basis6 -lenges of state and municipality-owned en-terprises, the Baltic Guidance on the Gov-ernance of Government-owned Enterprises was published by the BICG in 2010.

to listed companies. In the absence of their

danger that unlisted companies will refrain from developing an appropriate govern-ance framework, with negative implica-tions for their long-term effectiveness and success. Copying the widely-recognised principles of best practice for listed com-panies is also not a viable solution, as the corporate governance challenges of listed companies are distinct from those of unlist-ed companies.

Listed companies often have large num-bers of external minority shareholders, and may be run by professional managers without ownership stakes. The governance framework of such companies tends to fo-cus on ensuring that external shareholders can exercise effective oversight and control over management and the board of direc-tors. This is often a challenge due to the remoteness of most external shareholders from company decision-making (the so-called “principal-agent” problem), and the

-tions of a diffuse body of small sharehold-ers vis-à-vis management (the so-called “collective action” problem).

In contrast, most unlisted enterprises are owned and controlled by single individu-als or coalitions of company insiders (e.g. a family). In many cases, owners continue

-ment. Good governance in this context is not a question of protecting the interests of absentee shareholders. Rather, it is con-cerned with establishing a framework of company processes and attitudes that add value to the business and help ensure its long-term continuity and success.

had issued at least one code of governance. At an international level, the OECD Principles of Corporate Govern-

ance

agendas.

-

Lithuania.

6 This approach means that a company choosing to depart from a corporate governance code has to explain which parts of the corporate governance code it has departed from and the reasons for doing so. Green Paper on the EU

corporate governance framework, 4 April 2011, page 2.

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In many respects, unlisted companies face a greater corporate governance challenge than listed companies. Much of the govern-ance framework of listed companies may be externally imposed by various types of regulation and formal listing requirements. In contrast, unlisted companies have great-

governance strategy. This means that un-

-ous governance approaches.

Furthermore, in contrast to larger listed en-terprises, smaller unlisted entities may not have access to in-house support (e.g. legal advisers or company secretarial resources) to assist them in making important deci-sions about governance. Determination of the governance framework will largely be a matter for the shareholders and directors, who may need extra specialist governance expertise, relevant reference frameworks as well as tools to assist them in realising the ambition of professional governance.

These considerations have persuaded the BICG and other European directors’ as-sociations that there is much to be gained

issues of unlisted enterprises, and outlining best practice solutions in the form of a set of voluntary corporate governance principles.

2) Why corporate governance matters to unlisted companies

According to the OECD7, a corporate govern-ance framework consists of three main ele-ments:

A set of relationships between a com-pany’s management, its board, its share-holders and other stakeholders.

A structure through which the objectives of the company are set and the means of attaining those objectives and monitoring performance are determined.

Proper incentives for the board and man-agement to pursue objectives that are in the interests of the company and its shareholders.

The establishment of an effective govern--

proach to each of these issues is of equal importance to listed and unlisted compa-nies. However, there are a number of rea-sons why unlisted companies should spe-

governance.

7 OECD Principles of Corporate Governance (2004), page 11.

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I) Performance and internal e#ciency

Corporate governance is ultimately con-cerned with the decision-making processes, procedures, and attitudes that assist the company in achieving its objectives. It is the framework within which decisions are made and power exercised. Consequently, as the

and sustainability of its activities, it needs to give greater thought to issues of governance.

shift away from dependence on the unique contribution of the founding entrepreneur. Although the ability and dynamism of one individual may have been instrumental in establishing the enterprise, this is unlikely to be sustainable in the longer term. As the enterprise grows in size and maturity – or outlives the interest or working life of the founder – governance processes must be established to ensure continuity and suc-cess beyond the efforts of one person.

Indeed, the development of effective gov-

burden from the founder, facilitate a swift succession and allow access to a wider pool of expertise and know-how. The result may be improved leadership, decision-making and strategic vision. Improved gov-ernance may also make it easier to moni-tor and manage the various risks to which the company is exposed, particularly as it grows in size and complexity.

Governance will also become an increas-ing issue for unlisted companies as they

the primary source of funds is likely to be

networks, e.g. families or associated cor-porate groups. However, unlisted compa-nies may also turn to banks, venture capi-talists, and private equity investors in order

A greater reliance on such external sources -

tion of a more explicit governance frame-

that their investments will be well managed.

In particular, the involvement of additional owners in the company – even if the found-er retains a controlling stake – will require governance mechanisms to resolve differ-ences between shareholders with poten-tially diverging agendas.

A governance structure that sustains the

and other creditors – will contribute to the

the commitment of patient capital partners. The reward to the company of such a gov-

-nancing at lower cost than would otherwise be available.

II) Managing patient capital and illiquidity risk

Shareholders in unlisted companies are typically restricted in terms of their ability

the shares of unlisted enterprises are not quoted or traded on public equity markets. Furthermore, company law restricts the sale or marketing of shares in non-listed companies to the general public (or even to any persons without a prior connection with the company or its existing shareholders).

Restrictions on the transfer of shares may also be introduced by the shareholders themselves (e.g. through the company’s ar-ticles of association or shareholder agree-ments). As a result, the shareholders of

the uneasy position of being “captive” own-ers of a company.

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This lack of liquidity presents shareholders

are forced to commit themselves to the company for the medium to longer term. In contrast to the owners of listed companies, they do not have the option of easily selling their shares when they are in disagreement with the company’s strategy or if they be-lieve the company’s activities become too risky.

An effective corporate governance frame-work provides a way of mitigating this risk. It provides shareholders in unlisted compa-nies with some reassurance that, although there is no easy exit from their ownership stake, their interests will continue to be respected and safeguarded by the board and company management. Moreover the governance framework may also induce re-

shareholders that feel the necessity to exit the company’s share capital partly or com-pletely.

As a result, shareholders are more likely to -

thermore, they will be more comfortable in their role as patient capital partners, and be a source of support for the company over the longer term.

$$$) Building corporate reputation in line with societal expectations

Unlisted companies have to operate within a social context in which there exists grow-ing public scrutiny of corporate behaviour. The governance of companies is an issue of increasing interest for the media and civil society. Furthermore, the public demand for improved corporate accountability and transparency has grown in the wake of the

Existing corporate governance codes for listed companies are also raising the pro-

global corporate governance principles (e.g. those of the OECD) are shaping so-cietal norms of “appropriate” corporate structures, procedures and behaviour.

In assessing whether companies are gov-erning themselves appropriately, public opinion is unlikely to pay much regard to nuances such as whether an enterprise is listed or unlisted. Indeed, unlisted compa-nies may even be viewed with greater sus-picion by external observers due to their lower levels of transparency in comparison with publicly-listed entities.

Good governance can play a crucial role in gaining the respect of key external stakeholders – such as actual and poten-

local communities. It effectively provides a “licence to operate”, since it offers exter-nal stakeholders some assurance that the company is being run in an appropriate and responsible manner, with due regard for the interests of “non-insiders”.

the expectations of society, the company

laws, it may be operationally affected by the negative perception of employees and consumers. The implementation of a robust governance framework is the main means

can be mitigated.

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3) Constructing a governance framework – the key actors An effective governance framework estab-lishes stable and accepted relationships between shareholders, the board, manage-ment, and other stakeholders. In effect, it

between the main players involved with the

the effective operation of an enterprise. We consider each of the main actors in turn.

I) Shareholders

There is widespread recognition – both in company law and amongst the business community - that a key objective of a pri-vate sector company is to further the inter-ests of its shareholders. According to com-pany law in the Baltic countries, the board should act in an honest and reasonable

members (shareholders) as a whole.

However, in practice, shareholders do not tend to have direct power over the opera-tion of a company. The power of sharehold-ers primarily arises from their ability to ap-

making of the board of directors.

law (which establishes a baseline of share-

a company’s constitutional documents, i.e. the articles of association.

In addition, shareholders may enter into agreements amongst themselves. These

the rights and responsibilities of sharehold-ers, e.g. relating to the transferability of shares or the rights of different categories of shareholding.

Beyond compliance with the law, a gov-ernance framework must decide how the shareholder’s interaction with the company should be organised. For example:

How can shareholders call a shareholder meeting?

How can shareholders table resolutions -

ence or veto the decision-making of the board, nominate or dismiss individual di-rectors?

What information should be provided by the company to shareholders?

In addition, a governance framework may wish to highlight the responsibilities as well as the rights of shareholders. A proactive and constructive relationship between shareholders and the board will increase mutual understanding and commitment, both at times of crisis and during normal business conditions.

-ers in asserting their interests is that they are not necessarily a homogeneous group. There may be a variety of competing or

-ticular problem in family companies, where some family members are actively involved in the management of the company and others are not.

In such cases, it is important for a govern--

tionships between shareholders. This will

be anticipated and resolved in an effective manner. Also effective procedures for fam-ily governance can enhance the long-term success of family-owned companies.

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II) Directors

One of the main shareholder rights is to -

ers the board of directors is entrusted with. As such, the shareholders ultimately de-

framework.

According to company law in the Baltic countries, the board of directors is envis-aged as the primary decision-making body of the company (apart of shareholders’ meeting). It is collectively responsible for all aspects of the company’s activities. Not-withstanding the possibility for sharehold-ers to limit the power of the board, its broad responsibilities are:

to establish and maintain the company’s vision, mission, and values.

to establish its structure, strategy, and

to delegate authority to management, and to monitor and evaluate its imple-mentation of policies, strategies, and op-erational plans.

to account to – and be responsible to – shareholders and other stakeholders.

A governance framework will formally es-

composition, and the process by which di-rectors are appointed to the board.

The organisation and logistics of board meetings are important aspects of the gov-ernance framework. Key issues include the role of the chairman, the frequency of board meetings, the management of the board’s agenda, the nature of the infor-mation provided to directors, the taking of minutes, the nature and style of boardroom discussions and decision-making, and the role of the company secretary.

The governance framework should also de-termine if the board should delegate spe-

e.g. an audit, nomination or remuneration committee.

People as well as organisational struc-tures are essential to effective governance. Consequently, a governance framework will establish ways of identifying potential management and board-level talent, and ensure that directors understand their legal and moral responsibilities as company di-rectors (including their personal liabilities).

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DIRECTORS’ LEGAL DUTIES8

-al legal duties for directors of companies. These include the following9:

THE DUTY TO ACT FOR THE BENEFIT OF THE COMPANY AND ITS SHAREHOLDERS10

company and its shareholders and seek to implement the purposes of the com-pany.

THE DUTY TO ACT IN GOOD FAITH AND WITH REASONABLE CARE 11

Directors must act honestly and exercise reasonable care when performing the du-ties. The meaning of ‘reasonable care’ is judged according to what may reason-ably be expected of a cautious person

towards the company.

THE DUTY TO ACT WITHIN POWERS12

Directors must act in accordance with ap-plicable laws, the company’s constitution-al documents (i.e. the articles of associa-tion) and decisions of shareholders’ meet-ings, and only exercise powers for the purposes for which they are conferred.

THE DUTY TO ADHERE TO CONFIDENTIALITY13

while performing their duties and ensure -

tion is not disclosed to third parties.

8 ‘Director’ means any member of management or supervisory board of a company.

and their judicial interpretation may differ in each of the concerned jurisdictions.

10 Sometimes it is also referred to as the ‘duty of loyalty’. In the Estonian and Lithuanian legislation it is explicitly stipulated that directors shall be loyal to the company, while in the Latvian legal system the duty of loyalty is derived from the duty of care. Furthermore, in Lithuania the Company Law (Article 19 Paragraph 8) states that the bodies of

11 Generally, the duty of care presupposes that directors act on a well-informed basis having evaluated potential

directors shall perform their obligations with the diligence normally expected from a member of a directing body (Paragraph 35 of the General Part of the Civil Code Act). In Latvia directors are expected to act as an honest and careful manager (Section 169(1) of the Commercial Law). In Lithuania directors shall act in good faith and reason-ably with respect to the legal person and its members (Article 2.87 of the Civil Code).

12 See Paragraph 35 of the General Part of the Estonian Civil Code Act, Section 169 of the Latvian Commercial Law and Article 19(8) of the Lithuanian Company Law.

13 See Paragraphs 186 and 313 of the Estonian Commercial Code; Article 2.87 of the Lithuanian Civil Code. In Latvia

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14 See Paragraphs 181(3), 185, 307(3) and 312 of the Estonian Commercial Code; Sections 171, 221(5) and 309(3) of the Latvian Commercial Law; Articles 2.87(3) and 2.87(6) of the Lithuanian Civil Code and Article 35(5) of the Company Law.

THE DUTY TO AVOID CONFLICTS OF INTEREST14

Directors must avoid situations in which they could have direct or indirect interests

-pany (e.g. holding an ownership interest in a competitor). Directors must inform the board and/or its shareholders about a pos-

period of time.

THE DUTY NOT TO USE THE COMPANY’S PROPERTY FOR PERSONAL OR THIRD PARTY INTEREST

Directors may not use the property of the

third parties. The same rule applies in re-spect of the proprietary information of the company, i.e. directors are prohibited from disclosing such information or otherwise

III) Management

Management has the greatest capacity to determine the success or failure of the enterprise. Although managers are not

to-day basis. In that role, they need to be granted executive power to exercise dis-

A key aspect of the governance framework is to establish an appropriate level of ex-ecutive power to delegate to management. If too little power is granted – and a man-ager’s freedom of action is excessively con-strained – the company is likely to become

implement the board’s strategy. However, with too much power, the risk exists that management will lose touch with the inter-ests of the board and shareholders, and pursue its own agenda.

The governance framework must also work to align the incentives of management with shareholders and other stakeholders. The remuneration policy and contractual condi-tions with respect to the most senior man-agers, e.g. the managing director or CEO, are particularly important in that respect. Top management succession is also an im-portant issue that should be addressed by the governance framework.

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IV) Stakeholders

The role and impact of other company -

ciers, suppliers, local communities, and government – varies considerably across companies, sectors and countries. In the Baltics, companies have fewer formal ob-ligations to include stakeholders in their governance framework than in some other European countries15.

However, regardless of legal obligations, the governance framework should always take into account the interests of stakehold-

the stakeholder perspective into govern-ance arrangements could be considerable. Consequently, it is important to consider ways of establishing dialogue and con-structive engagement with relevant stake-holders.

4) Foundations of good governance – key concepts

The design of a credible framework of gov-ernance involves the linkage of the key corporate governance actors with a num-ber of widely-accepted principles of good governance.

I) Delegation of authority

In any company, the origin of authority is ownership. However, the company may soon reach a point in its development where the main shareholder is no longer able to si-

lead director, and manager. At that point, it

effective way to delegate authority from the owner to the board and the management.

The articles of association (or equivalent constitutional document) and shareholder resolutions exist to formalise the rights of shareholders.

The owner and/or the board should de-velop a systematic approach towards the delegation of authority and formalise this in writing. A schedule of matters reserved for the board and for executive manage-ment should be established, which sets out the parameters of the delegated authority

regarding decision-making powers).

Delegated authorities should be reviewed periodically to ensure that they remain ap-propriate given the structure, size, scope,

15 For example, in Lithuania directors of the company are expected to take into account stakeholder interests but not necessarily follow them. In this regard, repre-sentatives of employees must be informed, and con-sulted with, in respect of the implications for employees

However, there is no statutory requirement to include representatives of employees on company boards (in contrast to the requirements of codetermination legisla-tion in Germany, Austria and Scandinavia).

22

II) Checks and balances

A basic principle of good governance is that no one individual should have unfet-tered power over decision-making. There should exist “checks and balances” that subject the actions of individuals to scru-tiny, while the most important decisions should be taken on a collective basis.

for owner-managed companies, which are normally established on the basis of the autocratic control of a single individual (or small group of individuals). However, while such a governance approach may be vi-able in the early stages of a company’s de-velopment, it is not a sustainable model for the longer term. Building the right checks and balances is therefore a delicate exer-cise for any developing company and will probably necessitate a “phased” or step-wise approach to align governance needs with the founder/owner’s willingness to ac-cept external control.

-volved in a single person making all the decisions, a lack of appropriate checks and balances exposes the enterprise to hu-man weakness. Even the most capable of individuals can sometimes make mistakes or lose their ability to analyse issues in an objective manner.

To minimise these risks, it is important to establish governance procedures that sub-ject all decision-making to some kind of third-party scrutiny. There should also be

– each corporate actor (whether an em-ployee, manager, or director) should justify their actions to someone else. Corporate transparency is also an effective means of encouraging appropriate behaviour (see below).

within the corporate structure include split-ting the role of leading executive manage-ment (chief executive) from that of chair-man of the board, the utilisation of a “four eyes” principle when signing contracts or making important commitments on behalf

-nal auditor, and the involvement of inde-pendent directors on the board.

III) Professional decision-making

The focus of collective decision-making in most companies is the board of directors. However, directing an organisation through

supposed. Simply placing competent peo-ple of goodwill around a boardroom table will not necessarily result in an effectively functioning board. Building an effective board takes time and patience on the part

professional approach to boardroom pro-cedure.

The chairman has a particular responsibili-ty in welding a group of capable individuals into an effective board team. The chairman

-tween diverging views on the company and its future. An atmosphere of open discus-sion should be encouraged. Perspectives and viewpoints should be properly docu-mented in the minutes, allowing dissenting voices to be recorded. There should also be a clear formulation of decisions, so that the decision-making process is followed by decisive action.

23

It is also important to ensure that due care is taken over the choice of board members, and that board members have the neces-

responsibilities. Directors will need to un-dertake specialised professional training if they are to effectively make the transition from operational manager (with a focus on

-ny director (where they must exercise over-

IV) Accountability

Within a company, there should be a hier-archy of accountability. Each level in the hi-

and powers. However, these powers must be associated with meaningful account-ability regarding performance and the ex-ercise of powers.

The accountability hierarchy begins at the bottom of the pyramid, with each superior level monitoring and supervising the level below it. Employees are accountable to managers, who themselves report into the board of directors. Finally, the board of di-rectors is accountable to shareholders and other external stakeholders (including gov-ernment agencies and regulators).

For accountability to exert an effect over behaviour, it is important that each employ-ee, manager, and board member under-stands expectations about the nature and scope of his or her responsibilities. As the company expands in size and complexity, this will require formalisation in the form of

explicit business conduct rules (including ethical principles). At the board level, direc-tors should clarify their responsibilities by

-viewed and updated.

-pends on proper oversight. However, this will only be possible if there exists relevant information with which to evaluate behav-iour and performance.

For this reason, an appropriate framework of reporting and control is an important aspect of good governance. Senior man-agers, directors, shareholders, and other stakeholders need reliable and under-standable information with which to evalu-ate performance. In most cases, such re-porting will be undertaken by both internal departments (e.g. management account-ing reporting and internal audit) and exter-nal intermediaries (e.g. the external audi-tors).

V) Transparency

can be highly effective in encouraging high standards of behaviour. Directors, manag-ers, and employees are likely to give great-er thought to their conduct if they perceive that they are being observed. This per-spective is summarised by the maxim that “sunlight is the best of all disinfectants”.

24

activities may be mandated by law and reg--

cial statements). The nature of such statu-tory transparency is likely to be relatively

-nies may choose to voluntarily disclose more information than required by law as a

-mitment of external stakeholders.

Given the fact that unlisted companies are often labelled as “closed” companies, the case for greater external transparency will need to be made to a possibly sceptical company owner/founder. Rather than mak-ing sudden changes, an appropriate strat-egy may involve increasing company trans-parency via a stepwise approach towards greater openness.

A key stage in opening up the company to external scrutiny is taken by the appoint-ment of independent (non-executive) di-

become more open and accountable in respect of its decision-making and perfor-mance assessment. The replacing of the owner-manager or founding entrepreneur by external managers can also be per-ceived as an important step in this direc-tion.

At some stage, the unlisted company must make choices about the extent of its dis-closure to external stakeholders. This is im-portant if the company is seeking external capital or contemplating a future listing. But it may also be crucial for building reputa-tional capital.

-tablishing the legitimacy of the company as a responsible enterprise in society. In-creasingly, civil society views organisations that lack transparency with suspicion. The baseline assumption in the mind of the public is that opaque organisations have something to hide. This is a societal attitude that unlisted companies cannot afford to ig-nore, even if their regulatory obligations vis-à-vis transparency are less substantial than those of listed companies.

VI) Conflicts of interest

An important principle of company law is that directors have a duty to promote the success of the company as a whole. They

the activities of the company in favour of themselves or particular shareholders and/or stakeholders.

-

derives from his or her status as a direc-tor. The company should not be regarded as an extension of the personal property of the owner. Although shareholders have

to dividends) and powers vis-à-vis the board (e.g. to appoint and remove direc-tors), it is directors – not shareholders – that are charged with directing the affairs of the company. And this must be undertaken in the interests of the company as a whole.

managers or large shareholders of unlisted enterprises to accept or understand. They

-mous with their own. This may lead to a self-interested bias in their decision-mak-ing. At worst, it could lead them to seek

at the expense of minority shareholders or stakeholders.

25

situations may arise include the following:

-tions with enterprises controlled or man-aged by its shareholders, leading to a

A manager or director has a personal in-terest in the adoption of a particular cor-porate strategy or policy (e.g. his or her own remuneration or the sale of company property to related family shareholders), which leads him or her to be less than objective in decision-making.

Directors or shareholders encourage -

dividend policy, or requiring a subsidiary company to provide special guarantees or loans to a mother or another group company) or stakeholders with which they have a strong personal association (the promotion of a family employee or decisions on succession planning).

undermine the governance of the com-pany. Good governance demands that the company is being steered by the board in an objective manner, and not as a means

Consequently, a robust governance frame-

can be managed or resolved. Directors

of interest to the rest of the board, abstain -

pared to leave the board entirely in cases

could eventually become detrimental to the success of the company.

VII) Aligning incentives

The incentives of directors and employees are primarily (although not entirely) shaped

-neration is an issue that frequently attracts the attention of the media. Indeed, an im-pression may be gained from the public discourse that corporate governance is al-most entirely about remuneration, which is of course a gross distortion.

that they are not subject to the same degree of public scrutiny and mandatory transpar-ency regarding remuneration as publicly listed companies. However, unlisted com-panies have an equal need to ensure that remuneration policy is incentivising behav-iour from directors, managers and employ-ees in a way that is consistent with the long-term interests of the enterprise.

Furthermore, a credible and transparent remuneration policy can help win the com-mitment and loyalty of company stakehold-ers (e.g. employees, suppliers, providers of

-nity) to the company’s objectives.

Some important issues of remuneration policy include the following:

What are the relevant benchmarks and performance criteria in the remuneration process?

Who makes the decisions about remu-neration?

How much information regarding remu-neration issues should be disclosed?

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5) !e challenge of implementationThe implementation of sound corporate governance principles is not necessarily

the way that companies operate and a shift in the distribution of power in relation to cor-porate decision-making.

For example, the necessary steps may in-volve the inclusion of external parties in im-portant decisions, establishing meaningful chains of accountability, and the communi-cation and reporting of activities to stake-holders. Such steps may be viewed with suspicion by the original owner-manager or founding-entrepreneur.

Furthermore, improved governance is likely to be associated with the increased formalisa-tion of company processes and procedures. Many small and medium-sized companies may see this as imposing an unnecessary bureaucratic burden on their enterprises.

Consequently, there exist important prereq-uisites for the implementation of a corpo-rate governance framework:

the shareholders or the owner-manager – must themselves be convinced of the need to implement a robust governance frame-work. The commitment of these parties is essential in order to make governance work.

Although the governance framework should pay due regard to best practice principles, it should also be implemented in a manner that is both proportionate and realistic. Cor-porate governance is not an end in itself, but a means of adding value and providing continuity. Given the diversity amongst un-

-ples should be applied in a pragmatic and

circumstances of each company.

The implementation of a corporate govern-ance framework should also take account

development. A corporation will generally develop a new governance structure and approach in anticipation of its next major strategic move or phase in development or

-ing external capital, etc.). Such a change in governance will indicate its readiness to take the next step in its evolution.

Events in the company’s life cycle that may trigger a change in governance approach include the following:

Changes in the relationship between shareholders, the board and manage-ment. This may be triggered by the de-sire of the founder entrepreneur or family owners to withdraw from the day-to-day management of the company, and hand over executive responsibilities to profes-sional managers. A special trigger of governance change may be the decision

executive director on the board.

27

Expansion of the shareholder base by at-tracting additional internal (family, group) shareholders. This may trigger important challenges for the sole owner (e.g. the founder).

Change in the capital and shareholding structure, due to a desire to attract exter-

the ownership concentration of existing owners, and the entry into the company ownership of external shareholders.

-ness portfolio, its business environment,

The BICG principles of best practice pre-

are voluntary recommendations, leaving the companies the freedom to decide on the way in which they should be implement-ed in practice. Companies have the latitude to decide on the pace and depth of their governance implementation process.

The BICG principles do not stipulate any form of obligatory disclosure or an applica-tion of the comply-or-explain principle16. Ac-cording to the OECD17, an excessively formal

16 The comply-or-explain principle underpins the ap-plication of the Corporate Governance Codes for the

in Tallinn, Riga and Vilnius.. According to this principle, a company must either comply with the principles of the code or explain its reason for not complying in its an-nual report.

17 OECD (2006), page 14.

approach in the case of unlisted companies would have adverse implications for costs

should not be viewed as a corporate gov-ernance code, but rather as a set of propos-als aimed at increasing the professionalism and effectiveness of unlisted companies.

Once a choice is made regarding an ap-propriate governance framework, it should be implemented with a high level of disci-pline and consistency. The credibility of the

and stakeholders (e.g. employees, credi-tors, suppliers, customers) will be affected by the manner of its implementation. Fur-thermore, good governance requires more than the implementation of formal rules and processes. Equally important is the right governance attitude, which applies the spirit of key governance principles through-out the organisation.

If a new corporate governance framework is perceived to be just window dressing, it

good corporate governance.

Part II: Principles of corporate governance for unlisted companies in the Baltics

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!e BICG and ecoDa govern-ance principles – a phased approach

-nies, fourteen governance principles are presented on the basis of a dynamic step-wise process. This approach takes into ac-

terms of size, complexity, and maturity. Two categories of corporate governance princi-ples are proposed.

Phase 1 principles (principles 1-9) apply to all kinds of unlisted companies, regardless of size or level of complexity. Such princi-ples are viewed as broadly universal in their application, and do not necessarily require the creation of bureaucratic or costly gov-ernance procedures. They represent a core framework of basic governance principles that can be implemented in some form by all unlisted companies.

It should be recognised, however, that even

will probably necessitate a stepwise ap-proach. As has already been highlighted, the introduction of basic governance prin-ciples, such as external transparency, checks and balances, and external control, is a delicate exercise in an owner-managed

or decision-maker. Owners need to be con-vinced that the application of such princi-ples will bring a substantial return and fos-

Phase 2 principles (principles 10-14) are more sophisticated corporate governance measures that are relevant to larger or more complex unlisted companies, government-owned enterprises or enterprises with sig-

also be considered by unlisted companies that are seeking to prepare themselves for a future public listing.

The most important of the phase 2 principles is the decision to invite independent direc-tors onto the board. This is a landmark event in the evolution of an unlisted company. It normally signals an irreversible step towards good governance and is likely to exert an im-mediate effect over the culture of boardroom behaviour. The implementation of phase 2 principles is likely to increase the formality of governance arrangements. However, this is invariably a necessary step in larger or more complex enterprises in order to provide the necessary reassurance to owners or exter-nal creditors regarding the longer-term sus-tainability of the enterprise.

In short, the BICG and ecoDa principles offer a phased approach to corporate gov-ernance, both in terms of the way in which individual principles are implemented and in the transition from the phase 1 to the phase 2 principles. This provides a governance roadmap for family owners or founder-en-trepreneurs as they plan the development of their companies over the corporate life cycle.

After a statement of each of the govern-ance principles, a number of key points are listed. The application of these points is likely to underpin the implementation of each governance principle. This is followed by a discussion of the practical issues that are likely to be of interest to unlisted companies of differing sizes and levels of complexity in addressing each of the BICG principles.

It must be stressed that the objective of the BICG principles is to provide insight for unlisted companies in the design of a governance framework. They are not in-tended to be a straitjacket. Unlisted com-panies should exercise common sense in their implementation, and ensure that their response is both proportionate and tailored

30

Phase 1 principles – applicable to all unlisted companies

Principle 1: Shareholders should establish an appropriate constitutional and governance framework for the company. Key points

Key points

Shareholders should establish a basic framework of corporate governance through the company’s constitutional doc-uments (i.e. the articles of association).

There should be a formal schedule -

cally reserved for the shareholders’ de-cision and which are to be delegated to the board (see principle 2).

However, shareholders should minimise the extent to which the articles constrain the ability of the board to shape the de-tailed governance framework.

Practical considerations for unlisted companies

The company’s constitutional documents -

spect to many aspects of a company’s corporate and internal governance. They can be used to establish company rules relating to matters such as the issuance of shares, the different voting and divi-dend rights attached to different classes of shares, restrictions on the transfer of shares, the powers, role and conduct of board and shareholder meetings, and the appointment and remuneration of direc-tors (see also principle 2).

The articles essentially represent a con-tract between the company and its own-ers. They bind the way in which directors can subsequently exercise power over the company. A director that ignores the con-

acting ultra vires (“beyond powers”) and may be subject to legal sanction.

The detailed content of company articles is often given little attention by owner-managers in the early stages of a compa-

31

ny. In many instances, company founders rely on so-called “model articles”18

However, prior to further development of corporate governance, it is important for shareholders to consider if the existing constitutional framework is in the long-term interests of the company and adapted to its

In particular, shareholders should avoid embedding too much detail on govern-ance procedures in the articles of associa-

of establishing a governance framework. According to company law in the Baltic countries, they can only be changed via a special resolution of shareholders. Conse-quently, they impose severe constraints on the ability of the board of directors to tailor the governance framework to the changing needs of the company.

Shareholders should recognise that the board is the primary decision-making body of the company. This role should not be un-dermined by an excessively prescriptive approach to governance in the articles of association.

However, in some unlisted companies, there may be governance issues which

founding-entrepreneur or existing share-holders, e.g. concerning the transferability of shares or succession issue procedures. A constitutional framework which safe-guards the interests of the owners in these areas is likely to be an important prerequi-site for further development of the govern-ance framework.

Investors in unlisted companies take – in many respects – a bigger investment risk

than investors in listed enterprises. The il-liquidity of their shareholdings may require them to commit to the company for a rela-tively long period of time. A constitutional framework that protects their long-term inter-ests is likely to be an important determinant of their willingness to invest in the company.

Shareholders may also wish to ensure that

relation to the interests of other sharehold-ers. Company owners may have diverging aspirations for the company. In a relatively widely-held family company, for example, it is almost inevitable that such differing objec-

The constitutional framework offers a way of

procedures between shareholders. This will help to ensure stability over the longer term.

In contrast to the articles of association, shareholder agreements are contractual agreements between shareholders of the company. In some circumstances, share-holder agreements may be seen as a more

-ing shareholder rights than the company’s articles of association.

However, unlike the articles – which are pub-licly accessible documents – shareholder agreements lack transparency (they are con-

-ties), and there may exist uncertainty over their enforceability. Consequently, over time, shareholders should seek to move away from shareholder agreements as a means of safe-guarding their essential interests.

When undertaking changes to articles of association or shareholder agreements, shareholders should seek the guidance of

that any proposed changes are in accord-ance with relevant company law.

18 For example, in Lithuania so-called “model articles” are published by the Ministry of Economy, but they are not obligatory.

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Principle 2: Every company should strive to establish an e"ective board, which is collectively responsible for the long-term success of the company, including the defini-tion of the corporate strategy. However, an interim step on the road to an e"ective (and independent) board may be the creation of an advisory board.

Key points

The board’s role is to provide leadership of the company.

As an intermediate step on the road to an effective main board, small unlisted com-panies may consider the establishment of an additional advisory board, without formal decision-making responsibilities.

All directors must take decisions objec-tively in the interest of the company. As the company develops, inviting an independ-ent director onto the board can help in fo-cusing the board on the corporate interest.

The board should elect a chairman. The chairman is responsible for leadership of the board, ensuring its effectiveness on all aspects of its role and setting its agenda.

The board should appoint a Chief Ex-ecutive (or managing director) to lead the management team, and exercise executive authority over the operation of the company.

The board should set the company’s strategic objectives, and ensure that

-sources are in place for the company to meet its objectives.

The board is responsible for monitoring and evaluating management perfor-mance.

The board should set the company’s values and standards and ensure that its obligations to its shareholders and other stakeholders are understood and met. The board should be involved in the strategic development process and – as a minimum – approve the strategy, and ensure that it lies within the frame-work of shareholders’ expectations.

33

It is the responsibility of the board to ensure that the company complies with its articles of association as well as rel-evant legal, regulatory, and governance requirements.

There should be a formal schedule of matters which states which matters are

-cision and which are to be delegated to management.

Where directors have concerns which cannot be resolved about the running of the company or a proposed action, they should ensure that their concerns are re-corded in the board minutes.

Practical considerations for unlisted companies

In many smaller unlisted companies, the distinction between the members of the gov-ernance tripod of board, management, and shareholders is often unclear. An owner-man-

Nonetheless, it is important to recognise the unique role that the board plays in the leader-ship of the company. It has overall responsi-bility for the company’s activities.

At an early stage of a company’s develop-ment, it may be appropriate to operate many aspects of the board’s activities in a relatively informal and non-bureaucratic manner.

An interim step on the road to a more in-dependent board is the creation of an (ad-ditional) advisory board. In contrast to the main board, such a body lies outside the

a result, the decision-making powers of the owner-manager or controlling family on the main board remain undiluted. However, the advisory group helps improve the board’s ca-pabilities in terms of expertise and business

contacts (see principle 3). Over time, mem-bers of the advisory group can be invited to join the main board as directors.

As the company grows in size and complex-ity, so should the board. Conversely, the ad-visory board should diminish in importance. An advisory group cannot exercise proper monitoring and oversight over the company. Unlike a formal board, it has no right to obtain

activities (except in those cases in which it can be proved to be acting as a “shadow di-rector” of the company).

Consequently, the formalisation of board and governance processes should increase in tandem with the size and complexity of the company, and the extent of its reliance on ex-

As the company develops further, external and independent directors can play a crucial role on the route to a professional govern-ance framework. Introducing independent directors is a key step in the development of unlisted company governance (see also prin-ciple 11). The decision to invite external inde-pendent directors onto the board forms part of a professionalisation process. Its potential effect on boardroom behaviour and culture should not be underestimated.

At a relatively early stage, written statements should be developed to help the board clarify its objectives and strategy, and ensure that all concerned parties understand what is ex-pected of them.

A statement of the company’s strategy as -

ness plan prepared by the management and approved by the board – is a basic neces-sity. Over time, the board should also seek to develop a company manual that documents all company policies and procedures, e.g. in

34

relation to health and safety policy, legal and regulatory obligations, staff and procurement policies, etc.

responsibilities, reserved matters and del-egated authorities. However, given its posi-tioning as an intermediate corporate organ between shareholders and management, the

-sidual” manner, i.e. board duties exclude all rights and duties reserved to the sharehold-ers (meeting) or delegated to management.

Within the framework set by the sharehold--

ties, and on the duties and responsibilities it wants to delegate to management. Although

-ties will differ substantially between individual companies, some general frameworks can be described.

A schedule of matters reserved for shareholders (possibly at a sharehold-ers’ meeting), would typically include the following:

Approval of the annual accounts

Deciding on the dividend

Approval of changes to the articles of association/ and/or changes to capital structure

Appointment, remuneration, and dismiss-al of directors.

A schedule of matters potentially re-served for the board would typically in-clude the following:

and structure

Responding to shareholders and third parties

Supervising and controlling company progress

Supervising the Chief Executive or managing director

Approval of corporate plans

Approval of operating and capital budgets

Approval of major corporate actions (e.g. acquisitions, disposals, com-mencing or terminating of business activities)

Approval of borrowings or creditor guarantees (possibly above a certain amount)

Policy on external communications, e.g. with regulators, shareholders, or the media

management

Nomination and dismissal of the manag-ing director/CEO, and on his/her remu-neration (possibly also of other top man-agement, in consultation with the CEO).

A schedule of powers delegated to man-agement is likely to cover the following areas:

Preparing strategic proposals, corpo-rate plans, and budgets

Executing the strategy agreed upon by the board of directors

Executing actions in relation to board decisions on investments, mergers, and acquisitions, etc.

Opening bank accounts and authoris-

35

Signing of contracts

Signing of regulatory documents

Powers of attorney

External communication

Staff recruitment and remuneration

Establishing a system of internal control and risk management

Health and safety operations.

It is best practice to summarise such a schedule of delegation in a delegation poli-cy document, specifying the limits for each of the delegated matters.

The balance between matters reserved for the board and matters delegated to man-agement should be kept under regular re-view, particularly in a rapidly growing com-pany. Owner-managers need to develop an effective approach to delegation, and learn to spread decision-making powers to other directors and managers.

Boards should maintain a compliance -

nancial, legal, and regulatory requirements must be completed, and who is responsible for dealing with each item. Such a schedule is likely to include:

obligations relating to the preparation

tax compliance

banking facilities and covenants

health and safety compliance

insurance

Small unlisted companies may wish to ap-point an external party, e.g. a lawyer, ac-countant, or provider of company secretar-

its statutory obligations. In addition, it may be prudent to grant power of attorney to an external adviser to act when directors are unavailable or in an emergency.

As the company expands, it may be ap-propriate to appoint an in-house company

A key responsibility of the board is to pro-mote high standards of professional and ethical conduct amongst employees. As the number of employees expands, the standards expected should be summa-rised in a code of business conduct. This should be discussed with employees dur-ing induction and training periods. It also acts as a benchmark for evaluation during disciplinary proceedings.

The internal code could state the compa-ny’s expectations with respect to:

compliance with laws and regulations

standards of customer service

gifts or preferential treatment in respect of suppliers, customers, etc

the need for integrity and ethical busi-ness practice

company obligations to the general well-being of the community

support for employee personal development.

36

Principle 3: !e size and composition of the board should reflect the scale and complexity of the company’s activities.

Key points

The board should not be so large as to be unwieldy. The balance of skills and experience should be appropriate for the requirements of the business. Changes to the board’s composition should be manageable without undue disruption.

There should be an explicit procedure for the appointment of new directors to the board. Appointments to the board should be made after careful examina-tion against objective criteria.

The board should satisfy itself that plans are in place for orderly succession for appointments to the board and to senior management. The aim is to maintain an appropriate balance of skills and expe-rience within the company and on the board.

The period of appointment of directors should be carefully considered. The

open-ended appointments against the need to ensure planned and progres-sive refreshing of the board.

37

Practical considerations for unlisted companies

During the early years of the company’s ex-istence, owner-managers may be uncomfort-able about inviting outsiders onto the board. They may not yet be ready to share sensitive company information and decision-making powers with external persons. Hence the board often consists of owner-managers’ col-leagues, family members, or close friends.

As the company grows, more focus will be placed on the board, which is the key deci-sion-making body of the company. As the success of the company will depend more and more on the board, it is in the owner-manager’s interest to get the best possible people onto the board.

The board structure of companies differs across Europe. Although shareholders al-ways have the right to nominate (part of) the highest decision-making body, that body has different names according to the type of board structure in place.

In principle, a two-tier board structure is en-visaged by company law of all the three Baltic countries. I.e. supervision and management

-visory board and the management board, as opposed to the board of directors in a unitary board structure (e.g. in the UK). However, companies are permitted to adopt different board structures. For example, some com-panies may have only a management board consisting of solely executive directors (who combine their board role with a senior mana-gerial position) or a board comprising both executive and non-executive (some of which may be independent) directors. Other com-panies may have two boards: the supervisory board composed of non-executive directors

and the executive or management board (which is responsible for execution and oper-ational matters).19 It is also worth mentioning that in Lithuania the CEO must not necessar-ily be a member of the management board.

The composition of the board is vitally im-portant and should be addressed seriously. The company’s future may require a variety of expertise on the board including marketing,

resources, international trade, mergers & ac-quisitions, etc.

the ability of any form of committee to make decisions and exercise proper scrutiny be-

of 10-12 members. A smaller board size will improve the quality of communication and is likely to result in more focused discussions. They will also make board meetings easier to organise.

During the early years of the company’s ex-istence, owner-managers may be uncomfort-able about inviting outsiders onto the board. They may not yet be ready to share sensitive company information and decision-making powers with external persons.

However, this may result in the board lacking expertise in a number of key strategic areas, e.g. relating to strategy analysis, marketing,

international trade. As a result, it may make sense to create an additional advisory board,

-eas (see principle 2).

19 In Estonia and Latvia public companies must have the supervisory board and the management board.

38

However, an advisory board should only be regarded as an interim step. Over time, non-executives should be added to the

are also likely to insist on non-executive di-rectors joining the board (see principle 12).

In an owner-managed company, it is likely

of both chairman and chief executive (or managing director). A separate independ-ent chairman may not be commercially jus-

roles should remember that the responsibili-ties of chairman and CEO are distinct, and should be viewed separately.

Succession planning is a particularly impor-tant issue in owner-managed companies. The owner needs to consider if the ultimate objective is to pass on the business to younger family members or to seek an exit from the business through a public listing or trade sale. Answers to these questions will

-ate composition of the board.

Boards should comprise people with differ-ent perspectives, backgrounds, and experi-ence. Board renewal is important to ensure

Service on too many boards can interfere with the performance of board members. Companies should consider whether multi-ple board memberships by the same per-son are compatible with effective board performance.

It is important that members of the board

of shareholders. Transparency towards shareholders is therefore important in any company. Extra services to the company, undertaken on behalf of the board – and the associated remuneration – should be dis-closed to shareholders.

Principle 4: !e board should meet su#ciently regularly to discharge its duties, and be supplied in a timely manner with appropriate information.

39

Key points

Consideration should be given to the ap-propriate organisation of board meetings.

The chairman is responsible for ensur-ing that the directors receive accurate, timely, and clear information.

Management has an obligation to pro-vide such information. However, directors

from management where necessary. The board should establish explicit proce-dures which allow directors to approach management for further information.

The board should ensure that directors – especially non-executive directors – have access to independent professional ad-vice at the company’s expense where they judge it necessary to discharge their responsibilities as directors.

Practical considerations for unlisted companies

board, it is important to distinguish board meetings from management meetings, even in owner-managed enterprises.

Too many board meetings may result in the board becoming too operational. On the other hand, too few meetings may pose

be given to the appropriate number of board meetings.

Smaller companies will typically have four to eight board meetings per annum, pos-sibly including a full-day strategic board meeting. However, the exact number of

needs of the company.

stone” as far as possible. Frequent date changes can lead to poor attendance by non-executive directors.

The chairman should ensure that board

consider developing board guidelines with respect to meeting procedures and agen-da-setting. A typical structure for board meetings is as follows:

An agenda should be prepared by the chairman.

The agenda and supporting papers (if any) should be circulated in advance of

time to prepare.

40

Written minutes of board meetings should be taken. All decisions should be record-ed (including dissenting opinions), along with assigned tasks and timescales. The minutes should also give an overview of the main topics discussed at the meeting.

Board meetings should monitor progress against approved plans and budgets, and ensure full coverage of matters re-served for the board.

As well as promoting better decision-mak-ing, a track record of properly documented board meetings is an important indicator of professionalism. Furthermore it is an impor-tant legal safeguard for directors, and may assist smaller companies in obtaining ex-

Board members require relevant informa-tion on a timely basis in order to support their decision-making. However, a principal concern of many boards is not to increase the quantity of the information that they re-ceive. Rather, it is to increase the quality. Information needs to be summarised and formatted in a manner that makes it acces-sible and useful for directors.

It is the board’s responsibility to decide what information it wants. However, an informational tool that is widely used by boards is the “balanced scorecard”. This

-mance, and also tracks success according to a range of quantitative and qualitative criteria. It may include measures of cus-tomer satisfaction, indicators of training and professional development amongst employees, and qualitative indicators of progress on business processes, e.g. ma-jor projects or compliance with health and safety standards.

Directors may wish to supplement the in-formation they receive from management with information from other channels, such as departmental visits, with or without the chief executive present, and reports pre-pared by external think-tanks, academics, or regulatory bodies. However, the search for additional information should be under-taken after consultation with the chairman of the board and the CEO.

41

Principle 5: Levels of remuneration should be su#cient to attract, retain, and motivate executives and non-executives of the quality required to run the company successfully.K

Key points

A clear distinction must be made be-tween the remuneration of executives and non-executives. The former are full-time employees of the company, and are responsible for its operational activities. In contrast, non-executives

-ny employees, and dedicate their time to the company on a part-time basis.

these differing roles.

Members of the board are ultimately ac-countable to shareholders for their re-muneration. However, in practice, many

-pose to the shareholders’ meeting any change in their annual remuneration.

Levels of remuneration for non-exec-

commitment and responsibilities of the role.

Caution should be exercised when link-ing non-executive remuneration to com-pany performance.

The board should develop a formal executive remuneration policy and a transparent procedure for implement-

remuneration packages of individual executives and non-executives.

No one should be involved in deciding on his or her own remuneration.

Boards should compare the remunera-tion of their executives and non-execu-tives with that of other relevant compa-nies. But they should use such compari-sons with caution, in view of the risk of an upward ratchet of remuneration lev-els with no corresponding improvement in performance.

42

Boards should be sensitive to pay and employment conditions elsewhere in the company, especially when determining annual salary increases.

-muneration should be structured so as to link rewards to corporate and individual performance. They should be designed to align their interests with those of share-holders and other key stakeholders, and give these executives incentives to per-form at the highest levels.

implications of early termination of exec-

thought should be given to notice or con-tract periods. The aim should be to avoid rewarding poor performance.

Practical considerations for unlisted companies

Although board remuneration is ultimately a matter for shareholders, initial responsibil-ity over this area is often delegated to the

-ciation, although board decisions may still require approval from shareholders).

In contrast to executives, non-executive directors are normally remunerated on a

executives retain an objective and inde-pendent perspective on the activities of the company. For this reason, share options would not normally form part of a non-ex-ecutive’s remuneration framework.

Shareholders and boards may consider the rewarding of non-executives through stock. However, although stock ownership may increase the alignment of directors’ inter-ests with those of shareholders, the board should be aware that equity holdings may affect external perceptions of independ-ence (see principle 11). The compatibil-ity of stock-based remuneration with non-executive duties is ultimately a matter for shareholders.

Although care should be exercised in link-ing non-executive remuneration to perfor-mance, there should exist a relationship be-tween compensation and the attention and effort required of the individual director. Di-rectors should receive higher remuneration for a greater time commitment, e.g. arising from participation on board committees.

The board should ensure that executive remuneration (particularly that of the chief executive) is reasonable and aligned with the performance of the company. The per-formance of the company should be meas-ured not only in terms of the achievement

the basis of a qualitative assessment of the

longer-term objectives.

In an increasing number of companies, boards develop and disclose a remunera-tion policy statement covering board mem-bers and key executives. Such policy state-ments specify the relationship between re-muneration and performance, and include criteria that emphasise the longer-run in-terests of the organisation over short-term considerations.

43

For unlisted companies this external trans-parency may initially be a bridge too far, but open governance information can be a step on the road to a higher degree of pro-fessionalism and transparency (certainly for Phase II companies).

Good practice in executive remuneration is likely to consider the following elements in its design:

pay, and the linkage of variable pay to pre-determined performance criteria

Deferment of some proportion of variable pay

In cases where shares are granted, a minimum vesting period. A requirement to retain some proportion of those shares until the conclusion of employment

The reclaim of variable pay paid on the basis of data which subsequently proves to be manifestly misstated (“clawback”)

A limit on severance pay, and non-pay-ment of severance pay in case of poor performance.

It is important that both executive and non-executive compensation is as transparent and straightforward as possible. It is help-ful to canvas what other similar companies pay to ensure that compensation is not out of line, and many boards turn to external experts for this information.

However, boards should exercise caution in their use of remuneration consultants or

-ular, they should pay attention to consultants’

both executives and non-executives from the same company). The board needs to devel-op its own pay philosophy, and should avoid just going along with the crowd.

Principle 6: !e board is responsible for risk oversight and should maintain a sound system of internal control to safeguard shareholders’ investment and the company’s assets.

44

Key points

The board should attempt to identify the main risks facing the company. It should satisfy itself that all material risks are being appropriately managed.

The board should establish formal and transparent arrangements for applying

principles, and for maintaining an ap-propriate relationship with the compa-ny’s auditors.

The board should periodically assess the need to establish a formal internal control and risk management function. Moreover, a periodic check on the ef-fectiveness of the company’s approach towards internal control is necessary. Such review should cover all material

and compliance controls, and risk-man-agement systems.

45

Practical considerations for unlisted companies

Risk is an inherent part of being in busi-ness. The elimination of risk is neither a realistic nor a desirable aim. However, risk needs to be managed. The company should not expose itself to risks that it does not understand or which are not relevant to the success of its business.

In an owner-managed business, risk issues are likely to be addressed by the owner in a relatively informal manner. However, it is helpful to document risks where pos-sible, e.g. using a straightforward SWOT (strengths, weaknesses, opportunities, threats) framework or risk mapping, as this will help to focus decision-making and demonstrate that directors have ap-proached risk management with the neces-

risks have to be taken into account but also operational and strategic risks.

It is useful for companies to develop a ba-sic risk register, which is reviewed by the board on a regular basis. This will contain the following categories of information:

A description of the main risks facing the company

The impact should this event actually oc-cur

The probability of its occurrence

A summary of the planned response should the event occur

A summary of risk mitigation (the actions that can be taken in advance to reduce the probability and/or impact of the event).

Directors of smaller unlisted companies should approach professional advisers to gain input on how to establish appropriate internal control processes. As the com-pany grows in size and complexity, it will be necessary to move towards a more pro-fessional system of internal control. Strong

requirement if the company wishes to ob-

Notwithstanding the development of more sophisticated internal controls, the CEO should always view him/herself as the de

facto -age an appropriate sense of risk conscious-ness at all levels of the company.

In larger companies, risk management may become a particular focus of a boardroom audit committee or an internal audit depart-ment. However, even when many aspects of risk management are delegated to spe-

important that the board as a whole retains ownership of risk supervision.

All members of the board should have a feeling for the main business risks. Further-more, the board should establish ways of monitoring the development of these risks and seek reassurance that such risks are being managed in an appropriate manner by the management team.

46

A company manual should be available to all employees, and should outline poli-

risks to which the company is exposed. For example, policies should be developed with regard to:

anti-fraud

anti money-laundering

cash management

monitoring of banking covenants

business continuity

data security and reliability

records management

regulatory compliance

health and safety compliance.

Procedures which are likely to support an effective internal control environment are likely to include:

authorisation limits

segregation of duties

accounting reconciliations and monitor-

budgetary controls

controls over funds, expenditure, and ac-cess to bank accounts

security of premises and control over as-sets.

-sibilities, it is important for the board to en-courage the reporting of unethical/unlawful behaviour by employees. The existence of a company code of ethics should aid this pro-cess and should be underpinned by legal protection for the individuals concerned.

47

Principle 7: !ere should be a dialogue between the board and the shareholders based on the mutual understanding of ob-jectives. !e board as a whole has responsibility for ensuring that a satisfactory dialogue with shareholders takes place. !e board should not forget that all shareholders have to be treated equally.

Key points

The board should keep in touch with shareholder opinion in whatever ways

The chairman has particular responsi-bility for the effectiveness of communi-cation between shareholders and the board, and should discuss corporate governance and strategy with share-holders.

The chairman is the primary means of ensuring that the views of shareholders are communicated to the board as a whole. However, other directors should also be offered the opportunity of at-tending meetings with shareholders.

A key role of the chairman is to set the agenda of the Annual (and Extra-ordi-nary) General Meetings.

The relationship with the shareholders should be viewed as a continuous pro-cess and not limited to an annual formal meeting.

48

Practical considerations for unlisted companies

Shareholders of unlisted companies may particularly value a close dialogue with boards due to the illiquidity of their share-holdings. In contrast to listed companies, they are less able to express their views

through the buying and selling of their shares.

Engagement and communication with boards allows them to ensure that the com-pany is moving in a direction that is consist-ent with their interests (particularly with re-

-ny’s strategy). It is, therefore, a key way in which they may seek to manage the higher liquidity risk of their ownership stakes.

According to company law in the Baltic countries, unlisted companies are required to hold an Annual General Meeting (AGM). An AGM is a useful way to structure a dia-logue with shareholders that are not in-volved in the management of the company.

It is also likely to be a useful means of de-veloping board-shareholder dialogue in cases where the shareholders are a rela-tively large and heterogeneous group.

An AGM provides a well established mech-anism in which to review the activities and performance of the past year, and to dis-cuss the future prospects of the company.

However, in certain cases, shareholders may require a much more frequent and ongoing dialogue with the board. Alterna-tively, the main shareholders may still be actively involved in the company as man-agers and/or directors.

Ultimately, board-shareholder dialogue and engagement should be structured to suit the particular circumstances of each com-pany.

Boards should give particular thought to how they communicate the company’s

This should be done in a way that is both understandable and meaningful.

Furthermore, it should be undertaken in a spirit that recognises that a key duty of the board is to ensure that the activities of the company remain fully aligned with the inter-ests of shareholders.

49

Principle 8: All directors should receive induction on joining the board and should regularly update and refresh their skills and knowledge.

Key points

The rigour and formality of the induction

of the enterprise.

The chairman should ensure that the directors continually update their skills, and obtain the knowledge and familiar-

their role on the board.

The chairman should encourage board members to engage in professional

functioning as company directors.

50

Practical considerations for unlisted companies

Director orientation is an essential means of providing non-executive directors with the informational building blocks they need to effectively engage in strategic re-

for executive directors, who may come from a functional background and may not yet be used to exercising oversight across the company as a whole.

New directors may wish to request the op-portunity to meet fellow board members

request for orientation by a new director sends a strong signal that the director is serious about his or her role on the board.

In the Baltics, it is possible for directors to develop and update their director-spe-

-al board member. Such a professional

which to undertake continuing profes-sional development. It also establishes an ethical and disciplinary framework within which to hold directors to account. BICG provides such board-level education pro-grammes.

.

Principle 9: Family-controlled companies should establish family governance mechanisms that promote coordination and mutual understanding amongst family members, as well as organise the relationships between family governance and corporate governance.

51

Key points

The choice of family governance pro-cesses will depend on the size of the business, the number of family members, and the degree of involvement of family members in the business.

A family constitution or protocol should outline the vision and objectives of the

the roles of family governance bodies, and their relationship with the board of directors. It should also state key family policies, e.g. relating to family members’ employment, transfer of shares, and CEO succession.

Family governance bodies – such as a family assembly and a family council – provide family members with a forum in which to discuss the affairs of the family and the family business, and assist the development of a coordinated family ap-proach.

A clear distinction in governance status must be made between family institutions and the formal governance structures of the company. The role of the board, shareholder meetings, etc, must be fully understood by family members.

Practical considerations for unlisted companies

Most family companies are unlisted enter-prises. However, research shows that family businesses have a short lifespan beyond the generation of the founding-entrepre-neur. Very few survive into the third genera-tion of ownership. Family businesses can improve their odds of survival by setting the right governance structures in place and by starting the educational process of the sub-sequent generations as soon as possible.

Many founding-entrepreneurs or chairs of -

tiate their decision-making between fam-ily matters (continuity, valuation, liquidity, transmission, dividends, etc) and corporate matters (operation-related decisions).

When the company is still under the con-trol of the founding entrepreneur, few family governance issues may be apparent. How-ever, over time and several generations, the family is likely to increase in size and complexity. Family members may develop different preferences for the business. For

the company instead of distributing them as dividends may be supported by an owner-manager but opposed by a retired family member who relies on dividends as a main source of income.

A further problem for larger families is that members who work in the business have greater access to information than those whom are not directly involved in the busi-ness.

52

In such circumstances, it becomes desir-able to establish family governance struc-

company information, promote discipline among family members, prevent potential

business.

Once such structures are created, it must be clear that family governance should be distinct from business governance,

composition, duties, and matters to dis-cuss and decide upon.

A family constitution outlines how this family governance structure should work.

-spect to the following:

The family’s values, mission statement, and vision

The role of family institutions, such as the family assembly and the family council

The role of the board of directors, and its relationship to the family institutions

Policies regarding important family is-sues, such as employment policies with respect to family members, restric-tions on transfers of shares, and suc-cession policy with respect to the CEO

The nomination of the family members of the board.

A family assembly may meet once or twice per year, and brings together all members of the family. It allows fam-ily members to stay informed about the business and furnishes them with the op-portunity to voice their opinions. It helps

due to an unequal access to information and other resources.

A family council is a small group of fam-ily members or family representatives that acts as the primary decision-making body of the family vis-à-vis the company. It is also the main communication link between the family and the company and has a crucial role in conveying the expectations of the family owners to the board. It is normally elected by the family assembly.

Family institutions can play a useful role in coordinating and unifying the interests of extended families. However, the most important step for ensuring the long-term survival of a family company is the estab-lishment of a strong board with independ-ent non-executive board members20 (see principle 11).

Phase 2 principles – applicable to:

Larger and/or more complex unlisted companiesUnlisted companies with sig-nificant external financingGovernment-owned unlisted companiesUnlisted companies aspiring to a public listing

20 John Ward, Creating Effective Boards for Private En-

terprises (1991).

53

Principle 10: !ere should be a clear division of responsibilities at the head of the company between the running of the board and the running of the company’s business. No one individual should have unfettered powers of decision.

Key points

In larger companies, the roles of chair-man and chief executive (or managing director) should not be exercised by the same individual. The division of respon-sibilities between the chairman and chief executive should be clearly estab-lished, set out in writing, and agreed by the board.

Over time, companies should strive to nominate an independent chairman. However, as an interim measure, ap-pointment of the exiting CEO (e.g. the founding entrepreneur or pater familias) as chairman may be the most viable op-tion.

54

Practical considerations for unlisted companies

Smaller unlisted companies may not have the resources to appoint a separate board chairman. However, the roles of chairman and chief executive are fundamentally dif-ferent. Consequently, once a company ex-pands beyond a certain size and level of complexity, the board should give thought to splitting the two roles.

The chairman is pivotal to the operation of the board. He or she must coordinate the contributions of the non-executive directors to ensure that the executive team is subject

be compromised if the chief executive is

It is sensible to explicitly clarify the chair-man’s role vis-à-vis the role of the chief exec-utive through a formal statement of respon-

matters are reserved for the board and what matters are reserved for management. As a general rule, the chief executive leads the management team and runs the company while the chairman leads the board.

The statement of responsibilities should be reviewed periodically. Developing such a statement is a useful way of ensuring that everyone understands their role and is not stepping on anyone’s toes, and that there are no surprises.

Once appointed, the chairman is required to walk a narrow line. He or she must be

to intervene when required, but must avoid becoming too involved with the day-to-day business of the company. Board dysfunc-tion is likely to result when the distinct roles of the chief executive and chairman are not properly understood or respected.

Principle 11: All boards should contain di-rectors with a su#cient mix of competencies and experiences. No single person (or small group of individuals) should dominate the board’s decision-making.

55

Key points

Although there may be difference de-pending on the circumstances of indi-vidual companies, the board of larger

number of non-executive and independ-ent directors.

The largest unlisted enterprises – or un-listed enterprises working towards a pub-lic listing on a regulated market – should aim to add non-executive directors and preferably independent directors to

proportion of board seats (although the exact proportion will be a matter for the judgement of individual boards).

Care should be taken to ensure that non-executive or independent appointees have enough time available to devote to the job. This is particularly important in the case of chairmanships. The letter of appointment should set out the expected time commitment. Non-executive or inde-pendent directors should undertake that

-cant commitments should be disclosed to the board before appointment and the board should be informed of subsequent changes.

The chairman should facilitate the effec-tive contribution of non-executive and independent directors and ensure con-structive relations between all directors.

Non-executive and independent direc-tors should constructively challenge and help develop proposals on strategy.

Non-executive directors and independ-ent directors should scrutinise the per-formance of management in meeting agreed goals and objectives and monitor the reporting of performance.

Non-executive directors and independ-ent directors should satisfy themselves

systems of risk management are robust and defensible (although their approval remains a collective responsibility).

Non-executive directors and independ-ent directors should assume primary responsibility for determining appropri-ate levels of remuneration of manage-ment, including executive directors. They should also play a leading role in ap-pointing, and where necessary removing, executives, and in succession planning.

The chairman may decide to hold meet-ings with the non-executive directors without the executive directors present.

Non-executive or independent directors

(e.g. an initial mandate for three years, possibly renewable a couple of times). Decisions to extend terms of service should balance the need for company-

-sive refreshing of the board. It should also be recognised that serving for many years on a board may affect external per-ceptions of a non-executive director’s in-dependence.

On resignation, a non-executive director should provide a written statement to the chairman, for circulation to the board, if

running of the company.

56

Practical considerations for unlisted companies

Once a company reaches a certain size and level of complexity, an independent board, i.e. a board containing independ-ent non-executive directors and not entirely composed of company or family insiders, becomes essential to the long-term suc-cess and survival of the company.

Even for Phase I companies, the introduc-tion of external directors onto the board is a key event in the corporate governance development of an unlisted company. How-ever, once such companies become larger or have more complex shareholding struc-tures, they should progressively rely more on non-executive and independent direc-tors (eventually up to a majority of board seats for those interested in listing on the stock exchange). More diverse board com-

towards better governance and is likely to

boardroom decision-making.

non-executive directors on the board in-clude the following:

Bringing an outside perspective on strat-egy and control

Adding new skills and knowledge that

Bringing an independent and objective view from that of the owner

Making hiring and promotion decisions independent of family ties

Bringing an independent view whenever

the board

Acting as a balancing element between the different shareholders (e.g. members of the family) and, in some cases, serv-ing as objective judges of disagreements amongst family members or managers

-tions and other contacts.

Director independence is not a concept that

which may be of relevance in establishing the perceived independence of a non-exec-utive director include the following:

Has not in recent years been an employ-ee of the company

Has not a material business relationship with the company

Does not receive (additional) remunera-tion from the company during the period of appointment as a director (apart from the director’s fee)

Does not have close family ties with any of the company’s advisers, directors, or senior employees

Does not hold cross-directorships or

through involvement in other companies or bodies

-holder

Has not served on the board for an ex-tended period.

57

However, these are only guidelines. Ulti-mately, it is a matter for the board to deter-mine if the director is independent in char-acter and judgement, and whether there are relationships or circumstances which are likely to affect, or could appear to af-fect, the director’s judgement.

For example, extended service on a board is sometimes thought to negatively impact director independence. However, this will depend on the individual director. A director who serves on a board for an extended pe-riod should still be considered independent if that director possesses strength of char-acter and is willing and able to challenge management, while providing value added on the base of in-depth knowledge of the company and its strategic challenges.

Non-executive board members will not typi-cally have the same access to information as executive directors or the owner-man-ager. The contributions of non-executive board members can be enhanced by pro-viding them with access to managers with-in the company (although such contacts should be coordinated with management, and non-executives should take care not to undermine the authority of the manage-ment).

In certain circumstances, non-executives may also be assisted by offering access to independent external advice at the ex-pense of the company, although this gen-erally is undertaken with the knowledge of the board as a whole, in order to avoid creating a confrontational atmosphere be-tween executive and non-executive board members.

In smaller unlisted companies it may be tempting to seek the assistance of inde-pendent non-executive directors in un-dertaking management or staff functions. However, independent directors should not generally be involved in operational func-tions or take on a considerable consultancy role.

Independent directors need to retain a de-gree of distance from operational activities.

-agement team is taking the correct steps and is using available resources in the most

do assume an additional consultancy role, it should receive explicit approval from the board.

The board should consider appointing a company secretary who reports to the chair (via a joint report to the chief executive) to ensure that directors receive information in a timely way without excessive reliance on management (even if this is not a formal le-gal requirement). A board with its own sec-retariat will generally be in a stronger po-sition to demand information than a board whose secretary reports solely to the chief executive.

However, such designated administrative support for non-executive directors is only likely to be commercially viable in relatively large unlisted companies.

58

Principle 12: !e board should establish appropriate board committees in order to allow a more e"ective discharge of its duties.

Key points

A company’s committee structure should be proportionate to the needs of the company. However, most large unlisted enterprises are likely to require a nomination committee, remuneration committee, and audit committee. Other committees may be established if re-quired in particular circumstances.

terms of reference of the various com-mittees, explaining their role and the advisory authority delegated to them by the board. These terms of reference should be reviewed by the board on a periodic basis.

Committees should be provided with

duties.

Independent non-executive directors -

room committees.

59

Practical considerations for unlisted companies

A nomination committee can be established to lead the process for board appointments and make recommendations to the board. The role of the nomination committee is to evaluate the balance of skills, knowledge, and experience on the board, as well as amongst top management. In the light of this evaluation, it will prepare a description of the role and capabilities required for a particular board appointment, and propose a management succession plan.

A remuneration committee is granted del-egated responsibility for proposing the remuneration of all executives, including pension rights. The committee should also

of remuneration for senior management.

It may make sense to (initially) combine the responsibilities of the nomination and the remuneration committee into a single com-mittee.

The audit committee plays a particularly im-portant role in the monitoring and oversight of larger companies. The main responsibili-ties of the audit committee include the fol-lowing:

statements of the company

To review the company’s internal controls and risk management systems

To monitor and review the effectiveness of the company’s internal audit function

To make recommendations to the board in relation to the appointment or removal of the external auditor

To approve the remuneration and terms of engagement of the external auditor

To review and monitor the external audi-tor’s independence and effectiveness

To develop and implement policy on the engagement of the external auditor to supply non-audit services

To review the risk situation, and to monitor risk-management processes.

Given the relatively technical nature of the audit committee’s activities, the board should satisfy itself that at least one mem-ber of the audit committee has recent and

this is likely to mean that this individual

The majority of the members of the audit committee should be non-executive, and preferably independent directors.

Where there is no internal audit function, the audit committee should consider whether there is a need for an internal audit function and make recommendations to the board.

The audit committee should also review ar-rangements by which staff of the company

-cial reporting or other matters (“whistle-blowing”).

No one other than the committee chairman and members should be entitled to be pre-sent at a meeting of boardroom commit-tees. However, others may attend at the invitation of the committees.

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Principle 13: !e board should undertake a periodic appraisal of its own performance and that of each individual director.

Key points

The rigour and formality of the ap-praisal techniques utilised by the board

of the enterprise. Once again, a step-wise or phased approach is the best route ahead for smaller companies.

The chairman should use the appraisal process to obtain feedback on the ef-fectiveness of his or her management of the board.

Group appraisal should examine how the board operates as a collective de-cision-making body.

Individual appraisal should aim to show whether each director continues to contribute effectively and to demon-strate commitment to the role (including commitment of time).

The chairman should act on the results of the appraisal by recognising the strengths and addressing the weak-nesses of the board and, where ap-propriate, proposing new members be appointed to the board or seeking the resignation of directors.

Special attention should also be paid to the assessment of the collaboration with the (executive) management.

Practical considerations for unlisted companies

The chairman is responsible for working with the board to ensure that it is a high-performing team composed of the right people. He or she occupies a crucial posi-tion with respect to board functioning. Board dysfunction will result if the chairman is not

behaviour.

Chairs cannot improve their chairmanship without honest and constructive feedback. They must be open to input from the rest of the board in order to improve their perfor-mance.

There are many ways to undertake board appraisal, including self-evaluations, third-party facilitations, and peer reviews prior to re-election to the board. Board appraisal conducted by independent external facilita-tor is likely to be more objective in its rigour than self-assessment, and should be fa-

-plexity.

Board appraisals should be designed to elicit an honest discussion about what is going right and what is going wrong on the board. Some of the key questions that an appraisal should address include the following:

Is the distribution of power in the board-room appropriate?

management in board meetings?

Does the board have the right balance between expertise and independence?

Does the board correctly perform its duties? Are directors setting direction (guidance and advice on strategy) and monitoring the company (control and risk management) and its management?

time and effort to the company and their boardroom role?

Do board members have adequate ac-cess to information and advice?

shareholders and key stakeholders?

Are there personal factors that might in-hibit individual board members from ful-

objective manner?

Evaluating individual directors is a very sensitive issue, given the fact that the board is a collegial body, composed of peers. Therefore caution will be necessary in order

Here again, the chairman or an external fa-cilitator can be instrumental in bridging the

evaluations and a more global discussion of the board’s effectiveness, remuneration, and composition.

Feedback to the board as a whole can be provided by the chair or external facilita-tor. The chairman should also be able to provide individual directors with feedback as needed so as to encourage self-im-provement. The chairman should coach individual directors by providing continu-ous feedback and assigning them to work with others to improve board dynamics and teamwork.

62

The board should also be responsible for evaluating the chief executive. The chairman should drive the process. One approach for the chairman is to gather a self-assessment from the CEO and com-

gathered from the other directors and use this information in appraisal discussions with the chief executive. It is important to integrate in such an appraisal exercise the mutual evaluation of the collaboration between the board and the management.

A strong-minded independent chairman is in a good position to assess the per-formance of individual directors and that of the executive director or top manager. However, a chairman that is too close to management will lack objectivity and

management. This also holds for evaluat-ing the performance of the role of chair-man versus that of CEO. This highlights the need for the chairman to retain an

executive or otherwise appoint a lead di-rector and/or involve an external facilita-tor for such assessment.

Although a formal or externally adminis-tered boardroom appraisal process may only make sense for larger unlisted com-panies, all companies should recognise the importance of periodically evaluating the effectiveness of the board as a deci-sion-making unit.

Principle 14: !e board should present a balanced and understandable assessment of the company’s position and prospects for ex-ternal stakeholders, and estab-lish a suitable programme of stakeholder engagement.

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Key points

The board should publish an annual re-port that is tailored to the needs of its shareholders and its other stakeholders.

Practical considerations for unlisted companies

A strong disclosure regime that promotes transparency will be a pivotal feature of a company’s relationship with stakeholders. Disclosure improves public understanding of the structure and activities of the compa-ny, its policies with respect to environmental and ethical standards, and its relationship with the communities in which it operates.

The annual report is an important means of communicating with stakeholders (as well as shareholders). Apart from the traditional

-clude more information on the following corporate issues:

A statement of the company’s vision and values.

A narrative outline of the company’s busi-ness strategy and the likely risks associ-ated with that strategy.

A review of the company’s activities and performance, and a forward-looking as-sessment of its business environment.

A statement of its corporate governance principles and the extent to which it has

-ernance code, with additional govern-ance information, such as:

a statement of how the board oper-ates, including a high-level statement of which types of decisions are to be taken by the board and which are to be delegated to management;

the names of all the directors, includ-ing the chairman, the chief executive, and the chairmen and members of the nomination, audit and remunera-tion committees (if relevant);

the names of the non-executive direc-tors whom the board determines to be independent, with reasons for that assessment where necessary;

details of how any evaluation of the board, its committees, and its direc-tors has been conducted.

A summary of activities and projects of special relevance to stakeholders.

The content of the annual report will be-come more important as the company de-velops.

Social responsibility projects can act as a major point of engagement with stakehold-ers. They should be integrated into the company’s activities and included in man-agement’s list of strategic goals.

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Direct communication between directors and employees can be an effective way of driving a message home across an organi-sation. They help to ensure that everyone is “singing from the same hymn book”. In cases where such communication takes place on the initiative of individual direc-tors, such contacts should be in line with a general “internal governance” policy de-veloped by the board. If such policy is not yet developed, it is good practice to inform the chairman and CEO before taking any such steps.

However, in all such direct meetings with employees, the directors should empha-sise that the chief executive is ultimately in charge of the management of the company. Directors should ensure that they communi-

and avoid discussing detailed manage-ment issues with employees to minimise the risk of mixed messages.

The board can facilitate communications by providing a contact person with whom stakeholders may discuss any issues. Dur-ing times of change, it may be useful for the board to communicate regularly with stakeholders to explain what is happening at the company. For example, stakeholders of a company contemplating a major ex-pansion or retrenchment – or merger with another company – may wish to meet with the board to discuss the proposed strategy for the new organisation.

Stakeholders – including individual em-ployees and their representative bodies – should be able to freely communicate their concerns about illegal or unethical prac-tices to the board. Their rights should not be compromised for doing this. Unethical

may not only violate the rights of stakehold-ers but also be to the detriment of the com-pany in terms of reputation effects with an

It is therefore to the advantage of the com-pany to establish procedures and safe har-bours for complaints by stakeholders.

Association “Baltic Institute of Corporate Governance”Jogailos st. 4

LT-01116 VilniusLithuania

www.corporategovernance.eewww.corporategovernance.lvwww.corporategovernance.lt

2011